Transparency, Financial Accounting Information, and Corporate Governance

FRBNY Economic Policy Review / April 2003 65 Transparency, Financial Accounting Information, and Corporate Governance 1. Introduction ibrant public securities markets rely on complex systems of supporting institutions that promote the governance of publicly traded companies. Corporate governance structures serve: 1) to ensure that minority shareholders receive reliable information about the value of firms and that a company’s managers and large shareholders do not cheat them out of the value of their investments, and 2) to motivate managers to maximize firm value instead of pursuing personal objectives. 1 Institutions promoting the governance of firms include reputational intermediaries such as investment banks and audit firms, securities laws and regulators such as the Securities and Exchange Commission (SEC) in the United States,

and disclosure regimes that produce credible firm-specific information about publicly traded firms. In this paper, we discuss economics-based research focused primarily on the governance role of publicly reported financial accounting information. Financial accounting information is the product of corporate accounting and external reporting systems that measure and routinely disclose audited, quantitative data concerning the financial position and performance of publicly held firms. Audited balance sheets, income statements, and cash-flow statements, along with supporting disclosures, form the foundation of the firm-specific information set available to investors and regulators. Developing and maintaining a sophisticated financial disclosure regime is not cheap. Countries with highly developed securities markets devote substantial resources to producing and regulating the use of extensive accounting and disclosure rules that publicly traded firms must follow. Resources expended are not only financial, but also include opportunity costs associated with deployment of highly educated human capital, including accountants, lawyers, academicians, and politicians. In the United States, the SEC, under the oversight of the U.S. Congress, is responsible for maintaining and regulating the required accounting and disclosure rules that firms must follow. These rules are produced both by the SEC itself and through SEC oversight of private standards-setting bodies such as the Financial Accounting Standards Board and the Emerging Issues Task Force, which in turn solicit input from business leaders, academic researchers, and regulators around the world. In addition to the accounting standards-setting investments undertaken by many individual countries and securities exchanges, there is currently a major, well-funded effort in progress, under the auspices of the International Accounting Standards Board (IASB), to produce a single set of accounting standards that will ultimately be acceptable to all countries as the basis for cross-border financing transactions. 2 The premise behind governance research in accounting is that a significant portion of the return on investment in accounting regimes derives from enhanced governance of firms, which in turn facilitates the operation of securities Robert M. Bushman and Abbie J. Smith Robert M. Bushman is a professor of accounting at the University of North Carolina’s Kenan-Flagler Business School; Abbie J. Smith is the Marvin Bower Fellow at Harvard Business School and the Boris and Irene Stern Professor of Accounting at the University of Chicago’s Graduate School of Business. The authors thank Erica Groshen, James Kahn, and Hamid Mehran for useful comments. Robert Bushman thanks the Kenan-Flagler Business School for financial support; Abbie Smith thanks Harvard Business...

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